Locavesting: A Model to LIONize

How One Pacific Northwest Town Engineered a Quiet Revival

SOTW_2-14-12_PortTownsendWaterfront

Forty miles northwest of Seattle, perched at the tip of the Olympic Peninsula, lies Port Townsend, Washington. Its advantageous location, at the junction of Puget Sound and a strait leading to the Pacific Ocean, was considered so strategic that three forts were built around it in the late 1800s. The town was a major shipping hub in those days, home to ship captains and customs officials, and its port bustled with vessels carrying timber from the area’s rich forests and other goods. Already prosperous, the town really took off when it was poised to become the northwest terminus for the Union Pacific Railroad. Grand homes were built and investments made in anticipation of the “Key City’s” glorious future. But when the money ran out and the railroads stopped east of Puget Sound, the economic rewards fell to Seattle and Tacoma. Port Townsend, isolated on the western side of the Sound, began a steady decline.

SOTW_2-14-12_VictorianBldgIn a twist of fate, Port Townsend’s missed opportunity in the 19th century has led to a modern-day revival. Many of the town’s Victorian-era buildings, which might have been torn down in a more robust economy to make room for new ones, were spared. Restoration efforts began in the 1970s, and Port Townsend is now listed in the National Register of Historic Places as one of just three Victorian seaports. Those stately houses, along with the town’s postcard-perfect setting between the Olympic Mountains and the Port Townsend Bay, have lately drawn flocks of newcomers who covet the beautiful architecture and quality of life.

These new residents, many of them retired doctors, professors, and executives who have relocated here over the past couple of decades, have led an economic revitalization of the town. Rather than relying on railroads or outside investment, this is a homegrown effort that aims to create a resilient local economy less likely to be buffeted by the larger economic forces blowing across the Sound.

Today, Port Townsend boasts a thriving farmers market and a local food co-op. The historic Rose theatre, which operated from 1907 to 1958, was reopened in 1992 with the help of local residents, who put up around $85,000 and became shareholders in the theatre. And new businesses are popping up all over town.

Keeping Money Local

The quiet force behind many of these developments has been the Local Investing Opportunities Network, or LION, a group of residents who banded together to connect local investors with small businesses in Port Townsend and surrounding areas. The idea is to help to local enterprises flourish and keep more dollars circulating locally—money invested in and spent at local businesses tends to stay in the area, benefiting the local economy.

“That’s the way you keep profits local,” says Kees (pronounced Case) Kolff, a retired pediatrician with a neatly trimmed silver beard who’s been a LION member from the start. “We have so much profi t going out of small communities to corporate headquarters—it’s pitiful.”

LION members are like angel investors but with a hyperlocal focus. James Frazier, a former options trader and hedge fund manager who moved to Port Townsend with his family in 2006, is the group’s unofficial spokesperson. He became disillusioned with “in your face” capitalism, and now works as a financial advisor, when he’s not hiking, DJ-ing, or fielding calls about LION. The group’s members, he explains, “place a very high value on putting investment dollars back into the community and helping the multiplier effect really benefit our community. It’s the same thing with spending local, it’s just investing local. So money comes back as a return and the principal, when loans are paid off, gets reinvested back in the economy for another business. You can literally watch the money multiply, helping one person and then another and another.”

SOTW_2-14-12_BrokenSpokeThe group’s impact can be seen all over town. On Upper Sims Way, the Mt. Townsend Creamery churns out cheese made from local cows’ milk. Visitors to the shop can watch the cheese makers at work behind a glass wall. Nearby on Water Street is the Broken Spoke, a full-service bike rental, retail, and repair shop that opened in 2009. At the northern edge of town near Fort Warden State Park and overlooking the sound is Olympic Hostel, a youth hostel that draws families and backpackers for its agreeable accommodations and access to kayaking and hiking. In the historic Uptown district, a developer is finishing up small-scale cottages that blend in with the area’s low- key aesthetic and ecofriendly culture. And 12 miles south of Port Townsend in a rural area known as Chimacum is Finnriver Farm, a family-run organic farm and cidery that produces sparkling cider and fruit wines. All of these enterprises contribute to the vitality of the area, but few would be as successful, or perhaps exist at all, had it not been for the financial backing of LION members.

Their work has inspired other efforts as well. A group of 10 residents, including Kolff, has invested a total of $160,000 to install a solar array at the airport through a new state law that encourages public/private partnerships to promote solar energy. The 10 investors formed a limited liability company called Jefferson Solar to undertake the investment. Another grassroots organization, Citizens for Local Power, unshackled the town from its high-cost private electric company by creating the first new public utility in Washington in 40 years.

LION began humbly enough. When the local food co-op wanted to move to a bigger space in 2000, a number of residents and co-op members raised $490,000 in loans to fund the move. Then, another opportunity would arise, and another group would come together to raise funding and then disband. LION was created, as one investor explains it, “to bring together the individuals that kept bumping into each other trying to piece together these things in an informal way, and to streamline the connection between potential investors and lenders and opportunities.” For a couple of years, they discussed what structure the group should take and began drawing up agreements and other documents. By October 2008 they were nearly ready to launch, when the financial crisis gave them a shot of urgency. “We just said, we need to get going on this right now and step in as banks were pulling back,” recalls Frazier.

No Defaults, but Plenty of Cheese

The system is as simple and straightforward as you can get. Local companies can fill out an application on LION’s web site. Then they make a presentation in person to potential investors. LION members don’t make investment decisions as a group. Rather, investment opportunities are shared among the members, and individuals are free to make their own deals—although quite often several will invest together.

LION has grown from 8 charter members to about 20 today, including retired techies, small business owners, and other professionals. They are not poor, by any means, but neither are they necessarily in the rarified realm of accredited investors. When LION was officially established, members had already informally made well over a million dollars in local investments in about 15 companies. Since then, group members have made another 8 to 10 investments totaling more than $500,000. While there are some equity investments, most deals have been in the form of loans, with interest rates averaging from about 5 percent to 7 percent. To date, there have been no defaults.

Some members set aside just a small amount of their overall portfolio for local investments, say 5 percent or 10 percent, and view it as another asset class to diversify their holdings. Others, such as Kolff and his wife, Helen, have invested 20 percent of their retirement assets in local business and land. “It’s a significant part of our investment strategy,” says Kolff, who served as mayor of Port Townsend from 2001 to 2003.

Kolff says one of his borrowers, a candlemaking company, had to extend the term of its loan for a couple of years when the once-successful operation began to struggle. The business eventually folded, but the owners honored the loan and paid it back in full. “We knew them personally and we understood the situation,” says Kolff. His loan didn’t save the business, “but it at least allowed them to shut it down in an orderly way.” (Try that with Bank of America.)

SOTW_2-14-12_ReCycleryThat kind of personal connection and understanding is at the heart of local investing. It’s the kind of lending that banks used to do, when they were small and community-rooted.

Kolff has even made a zero-interest loan. When Chauncey Tudhope-Locklear, a 20-something born and raised in Port Townsend, had an idea to start a nonprofit bike collective, it resonated with Kolff. The Recyclery, as it is called, rebuilds and repairs bikes and holds free workshops. It also sells affordable, rebuilt bikes and runs an adopt-a-bike program for Port Washington youths. On the other hand, Kolff gets 7 percent interest on his loan to the Broken Spoke, the decidedly for-profit bike shop on Water Street.

But of all Kolff’s investments, the Mt. Townsend Creamery may be his favorite—and not just because he has elected to take part of his dividends in cheese. The creamery’s founders, Matt Day and Ryan Trail, set out to revive the area’s vanishing dairy tradition. At the time, there was just one local cheese maker, who made a small amount of goat cheese mainly for herself. The partners found a location in town to build their plant and a farmer who would supply milk, but the endeavor required a significant amount of capital. They mustered about $180,000 in personal equity, presented their business plan to LION, and raised $150,000 in equity (for a 25 percent stake).

“The numbers weren’t knocking anything out of the park,” says Day of the business plan. “But there was a reasonable rate of return. It’s not like investing in Google.”

SOTW_2-14-12_MtTownsendCreameryStill, the venture was successful from the start. The partners made their debut at the farmers market in April 2005 with their soft-ripened and home-style cheese. In the course of two hours, they sold out of everything they had. They made two trips back to the creamery and, by the end of the day, had sold out their entire inventory. While they are still a popular draw at the farmers market, about 65 percent of their business now is selling wholesale to restaurants and stores. The Creamery’s sales have grown around 30 percent each year. In 2009, sales approached $1 million. In 2010, the company was on track to hit $1.2 million. “We’re building value over time,” says Day.

In more ways than one, as Kolff sees it. “You have a small local creamery that hires local people and the profi ts stay local. They use milk from local dairies and guarantee them a good price so they have assured sales of their milk. That also reduces shipping and transportation-related greenhouse gas. The used whey from the cheese-making process goes back to local farms to feed the pigs—it’s a closed loop!” he exclaims. “I feel great about my investment with the creamery on about 10 different levels.”

Day and Trail went back to LION in 2008 for a $70,000 loan, at 8 percent interest, to install a bulk tank. That allowed them to store milk, rather than rising each morning to clean the tank in the truck and drive to the dairy farm 25 miles away—all before the dairy farmer got going in the morning.

Now, the 3,000-square-foot facility on Sherman Street is beginning to feel tight. The partners would like to find a bigger space that would allow them to increase capacity, expand the variety of products they offer, and sell to a broader swath of the Northwest. “We’re building a sound financial case to go back out” to investors, says Day

Small Is Beautiful

LION has inspired similar groups in Madison, Wisconsin, and elsewhere, and Frazier spends much of his time fielding calls from other communities interested in setting up LION-like investment groups. It’s not hard to do. LION makes available on its website its three key documents: a membership application for prospective investors, a membership agreement that lays out policies and procedures, and an investment opportunity submission form.

But, Frazier warns, the model is not easily scalable. Each investment requires a lot of work; potential borrowers must be interviewed and their businesses vetted. And the investments aren’t very liquid—they can’t be flipped for quick profit. “It really takes it back to the original model of investing. It’s all handshakes and getting to know someone and building trust before you invest,”says Frazier. “It’s not really efficient so it’s forced to be small, to be person to person and to create community. That’s the beauty of it, in a way.”

Kolff believes the LION model can work for any group of people who share a focused interest. These days, he says, “More and more people are saying, ‘We need to preserve our local small businesses.’ If you took every single person in this county and said, let’s put 20 percent of your investments into local businesses, my god, the local wealth would be incredible.”

Still, for all of its potential, LION operates in a sort of gray area, as far as securities laws are concerned. Unlike most private and angel investors, LION’s members are not necessarily accredited investors, who have the SEC’s blessing to wade into small, private deals that the agency considers risky. “We’re more going on the concept of the securities law exemption for nonpublic offerings,” explains Frazier, who is a registered investment advisor.

By that, he means the “private offering exemption” under Section 4(1) of the Securities Act. But what exactly constitutes a nonpublic offering is open to debate. Frazier points to a 1962 SEC ruling that attempts to clarify when such exemptions from registration are allowed. Traditionally, the private offering exemption has been available for “bank loans, private placements of securities with institutions and the promotion of a business venture to a few closely related persons,” the ruling explains. So, as long as the potential investors have a preexisting relationship and familiarity with the offerer of the securities, it can be considered a nonpublic offering. “In a community like ours,” says Frazier, “that’s usually if not always the case.”

Frazier is comfortable with his interpretation of the SEC rules, but concedes that it does entail risk. “We have not had a securities lawyer charging $550 an hour go over the whole concept,” he says. “While I think that our idea works well in principle, if there is someone that doesn’t know someone else and there is an investment made when they’re not really fully educated on what’s going on, (the SEC) would have grounds to say that there was a violation of the law. It’s something that we’re really careful about, to keep it small and in the family of the community of people who know each other.”

That’s one reason the group holds regular social events so people can get to know each other. And they keep a low profile, just to be safe.

Game Plan for Locavestors

The Local Investing Opportunities Network (LION) is a group of investors in Port Townsend, Washington, formed to promote local investment. LION doesn’t invest as a group, but facilitates investment by bringing together local investors with local businesses in need of loans or equity. LION members are not necessarily accredited investors, so companies rely on a private offering exemption for preexisting relationships.

Pros:

  • The level of familiarity and knowledge that comes with a local investment can provide investors with greater insight into the business.
  • Interest rates on loans generally reflect the higher-risk premium.
  • Dividends and repayment may also take the form of in-kind payment—for example, cheese in the case of the Mt. Townsend Creamery.
  • The rewards are more than financial; by investing in local enterprises, you support your local economy and increase the local quality of life.


Cons:

  • Private transactions carry risk. There is no regulatory oversight or recourse, and investors must conduct their own due diligence.
  • If loans are unsecured, the investment could potentially be lost if the business fails.
  • Equity investments are likely to be illiquid and long term, with no easy way to cash out.


The Bottom Line: For patient investors who are comfortable vetting investments and taking some risk.

For More Information

LION’s website contains useful information and documents including a membership application; membership agreement, policies, and procedures form; and an Investing Opportunity Submission form.